What types of debt should be avoided?

Getting into debt or borrowing money at certain stages of our lives can be unavoidable. As a young adult, you might need to borrow to fund your tertiary study, or purchase your first car so you can get to and from work. As you move through your 20s or 30s you might take on debt to purchase your first home, an investment property or business. 

Once you have a credit history as a working adult, it is easier to apply for a credit card, store card, laybuy purchase or personal loan. In your 40s and 50s, you might take on debt for lifestyle reasons – financing a dream holiday before the children all leave home, upgrading your vehicle or undertaking a much needed renovation. 

There are many reasons to consider applying for a loan, but there are some kinds of debt that can be more difficult to repay. Types of debt to avoid include those with high interest rates and high fees. Make sure you understand all the fees involved when considering borrowing – initial processing and application fees, fees for early repayments and late payments, ongoing administration or account fees.   

The Top 3 Types of Debt to Avoid

1. What is a Payday Lender? 

Payday loans are short term loans, often for quite small amounts of money. They are designed to help people make ends meet until their next pay day – so can be for just a few weeks. Payday loans are targeted at people needing quick cash or emergency loans.

The catch is that you’ll pay the price for convenience. This type of loan has one of the highest interest rates. Their upfront and ongoing fees are also expensive compared to other types of lending. These lenders are focused on making as much revenue as possible from their short term customers. The reality is that the high fees and interest applied to these loans, makes it difficult for people to repay as quickly as they’d like.

A watchful eye is kept on payday lenders, by industry bodies such as the Commerce Commission. High-cost lending rules introduced in 2020 to better protect New Zealanders from lenders who sought to take advantage of low income consumers. Currently, the highest interest rate that can be charged is 292%. Before the 2020 law change, some lenders were getting away with charging up to 800% in interest. 

2. What is Buy Now Pay Later?

Buy Now Pay Later (BNPL) is a useful payment mechanism for people that use it wisely. It is also known as Afterpay or laybuy. Considered short term financing, BNPL allows consumers to make a small payment now and receive the product immediately. They can then repay it at regular intervals, over a short time period. The BNPL relationship is between the consumer, lender and the retailer that the product(s) are purchased from.

BNPL works well for many consumers with fixed, low disposable incomes. Spreading payments over time can really help with cash flow problems. Where consumers become unstuck is when they take on too many BNPL purchases, and start missing payments. When a late payment occurs, consumers are charged a late payment fee, then further missed payment fees if the debt remains unpaid.

Unlike more formal types of lending, undertaken with a bank or finance company, BNPL has not been  treated as a “consumer credit contract” because they do not charge interest, credit fees, or require security. BNPL providers will need to start complying with more CCCFA obligations from 2 September 2024. This will ensure that fees charged are ‘reasonable’ and ‘responsible lending’ practices are being used. This is great news for consumers.   

There is concern that younger consumers are drawn to BNPL options as they are easy to access. A recent Auckland University of Technology survey showed that 20% of its 18-34 year old participants, were using BNPL ‘poorly’. This meant they incurred late payment fees, would prioritise their repayments over other necessary expenses, or ended up borrowing from other lenders to repay their BNPL debt.

3. What are high interest credit cards?

Credit cards have been a useful personal finance tool for decades to help us manage emergency expenses, make purchases when travelling overseas, access quick cash and more recently, so we can make online purchases. It’s worthwhile reacquainting yourself with your credit card’s interest rate, annual fees and fee structure for late payments, rewards programmes, cash advance fees and any other fee types. 

Retailers can also choose to add to the cost of your purchase via credit card by adding a credit card processing fee – typically a percentage of your transaction as they get charged by the credit card company. All these costs can creep up to make your seemingly simple purchase of a new lounge suite, an expensive choice. 

If you’re someone that struggles to pay off your credit card in full every month, the interest rate will be of particular importance to you. Any outstanding balances will be charged interest so you will want to ensure the interest rate is competitive against other types of credit cards, or other types of lending. 

You might find that a personal loan to finance your next holiday will provide you with a better interest rate, more flexible repayment options and lower fees. We share more tips to manage high interest rate credit cards.

What is healthy debt?

Just like you can eat good and bad fats, you can take on good and bad debt. So what is healthy debt? How do you know if you have good or bad debt?

A good rule of thumb is whether the debt you have now is enabling you to grow your wealth or financial position. Examples of good debt are student loans that will enable you to have well paying work prospects, a home loan that will enable you to have a valuable asset in the future. If your current job needs you to be able to drive to and from work, then seeking finance to invest in a car will enable you to earn an income.

On the other side of the coin is bad debt. Borrowing money for day to day expenses or to purchase assets that decrease in value shortly after purchase are generally considered examples of bad debt. Debt options where you aren’t paying over the minimum repayment amounts, and your debt moves from short term to long term is also an example of bad debt.

If you do find yourself in a situation with multiple bad debt types, consider applying for a debt consolidation loan. A debt consolidation loan can help you to simplify your debt situation by rolling multiple debts into one single debt. The benefit of doing this is that you’ll often end up with a lower interest rate loan, with a single repayment required. Do your homework to see if a debt consolidation loan will reduce your interest rate.

Personal finance advice

Unsure of how to manage your money? You can access free personal finance services or pay for professional personal finance advice. The Financial Markets Authority provides useful information on seeking financial advice.

How much can you borrow with a personal loan? 

With Nectar Money you can borrow unsecured up to $30,000, or as little as $2,000. Use our loan repayment calculator to find out how much you could get. We offer debt consolidation loans to simplify multiple debt repayments, and emergency or urgent  loans to meet your cash flow needs.

Getting started with Nectar Money

Do you need a great rate on a personal loan? We’d love to help with your personal loan requirements. Find out how much you could borrow and learn more about our personal loans. You can get started with Nectar Money and get a personalised loan quote online which will include your interest rate, maximum borrowing amount and repayment options. Borrow better, faster today!*

*Nectar Money’s lending criteria and responsible lending checks apply.